Covered Calls

ZYX closes above 45 at expiration - assignment on short call

In this case, the short call will expire in-the-money and the call writer can expect assignment. No matter how high ZYX has risen, the investor is obligated to sell his shares at the strike price of $45 per share so the upside profit potential on the shares is capped. However, the investor keeps the option premium received and will realize the position's maximum profit calculated in advance. This amount would be: ($45 strike price - $41.75 stock purchase price) + $1.25 call premium received = $4.50, or $450 total. Any dividends received before expiration would increase this profit amount.

Consider the overall return on this covered call position for the three-month life of contract if the stock is called away at expiration:


table


The covered call writer's profit of $450 would represent a return on his initial $4,050 investment of approximately 11.1% over the three-month life of the call contract. A stock investor purchasing 100 ZYX shares at the same $41.75 per share, not writing a call, and selling the shares at $45 would see a profit of $325. This would represent a return on his investment of only approximately 7.8%.

Before expiration the price of ZYX stock might rise well above the $45 strike price, and assignment at expiration seems likely but undesirable. In this case the investor may make a closing purchase of the ZYX 45 call at any time before it expires. The result would be an unrealized profit on the ZYX shares offset partially by a losing transaction on the option repurchase, but the investor retains his shares with the possibility of continued profits on the upside.

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